Given that the immediate focus of U.S. sanctions on Iran is the nation’s oil sector, the Islamic Republic is concentrating on pushing its already significant petrochemicals capabilities to generate much-needed export revenues. Tehran also believes that foreign companies – particularly those in Europe – are much more likely to defy the U.S. in this sector than in the oil industry. To this effect, last week saw the chief executive officer of Iran’s National Petrochemical Company (NPC), Behzad Mohammadi, state that the country is now preparing its ‘master development plan for downstream petrochemical industries’.
This pivot to petrochemicals makes sense with the Songhor Petrochemical Projects plant set to be ready within 14 months. Also, the annual growth rate of the global crude oil industry is at best 1%, while the global petrochemicals sector is nearer 9%. According to Behzad Mohammadi, “the volume of the petrochemical industry’s trade in the world is worth US$3,800 billion annually and Iran can move more rapidly in the industry, given its massive oil and gas reserves,”.
Under the previous US sanctions – even when the E.U. dramatically increased its sanctions against Iran in 2011/2012 – the petchems sector was the foundation of Iran’s ‘resistance economy’ model. The concept of this model was to generate value-added returns by leveraging intellectual capital into business development wherever possible. As it stands, 55 petrochemical plants are operating in Mahshahr, Assaluyeh and other areas of the country with a capacity of 65 million tons per year (mpty), of which 31 million tons of products are sold, and about 22 million tons are exported to different destinations in the world.
Mohammadi, in fact, expects that Iran’s petrochemical production capacity will cross the 100 mtpy threshold by 2025, once the sector has completed its under-construction projects. This is partly due to many of Iran’s major customers in Asia (most notably China) having stated at a governmental level that they will not follow the new U.S.-led sanctions and partly due to the E.U. having moved so quickly to reactivate its ‘Blocking Regulation’, which prohibits European companies from complying with the re-imposed U.S. sanctions. The E.U. has also constructed the INSTEX payments mechanism to continue to do business with Iran, whilst Iran at the end of April announced the creation of the Special Trade and Finance Institute (STFI) to dovetail into INSTEX.
The NPC’s investment director, Hossein Ali-Morad, highlighted last week that 13 foreign companies signed memoranda of understanding with the NPC immediately after Iran struck the 2015 Joint Comprehensive Plan of Action (JCPOA) with the P5+1 group of nations (the U.S., U.K., France, Russia, and China plus Germany). This would have resulted in at least US$15 billion in foreign direct investment in Iran’s petrochemical industry. Related: Is There Really An Oil Shortage?
From a legal perspective, Iran’s petchems sector has always occupied a somewhat grey area as far as sanctions have been concerned. “When the previous set of major sanctions were at their height, Iran’s petrochemical industry was the subject of U.S. and E.U. sanctions, and the only way for Iran to sell such products ‘legally’ was to customers outside the U.S. and E.U.,” a Washington DC-based senior lawyer with an international litigation and arbitration specialist legal firm, told OilPrice.com earlier this week.
At that time, secondary sanctions were in place in the U.S. on any person worldwide that purchased, acquired, sold, transported, or marketed Iranian-origin petrochemical products, or provided goods or services valued at US$250,000 or more (or US$1 million over a 12-month period) for use in Iran’s production of petrochemical products. In the E.U. there was a ban on the import, purchase, or transportation of Iran-origin petrochemical products, and on the export to Iran of certain equipment for use in the petrochemical industry.
“In practical terms, though, there was a lot of playing around with these rules by European and Asian customers to ensure that they got what they needed, and Iran’s petchems sector was the principal source of foreign currency revenue for the country for years, even over this extreme sanctions period,” Sam Barden, chief executive officer of global energy consultancy and trading firm, SBI Markets, in Melbourne, told OilPrice.com earlier this week.
In stark contrast to the previous sanctions era, there are currently no E.U. sanctions on Iran and nor are there plans to impose them. From the U.S. perspective, it cannot currently exert jurisdiction for ‘primary’ sanctions unless U.S. persons are involved – U.S. banks, U.S. employees, and so on. With respect to secondary sanctions, the U.S. position appears to be that any company that provides support to Iran’s petrochemical industry is subject to sanctions, according to the Washington-based legal source. “So any company planning to continue this business is betting on one of three things: that [U.S. President, Donald] Trump won’t sanction them, or that they stay engaged in activity below the US$250,000 or US$1 million over 12 months thresholds or, thirdly, that they plan to evade sanctions through dodgy activity,” he said.
The rewards for companies looking to stick with the deals struck in Iran’s petchems sector are enticing. In broad terms, Iran has the world’s fourth largest proven oil and first largest proven gas reserves, the latter being exceptionally rich in ethane, a pivotal feedstock for petrochemical plants. Iran’s Petroleum Minister, Bijan Zanganeh, recently announced that the country’s annual ethane production capacity will reach 17.6 mtpy by March 2021, with 12.75 mtpy to be achieved by the end of the next Iranian calendar year to March 20, 2020. This compares to current total ethane output of just under 8 million tons.
Cognisant of this advantage, Iran has kept the price of ethane low, so that ethylene production costs based on ethane feedstock in Iran are comparable to the lowest cost ethylene producers of Saudi Arabia, the U.S., and Canada. Polypropylene and polyethylene remain the two most utilised plastics products in the world, with demand from China consistently growing, to the degree that annual revenues are expected to exceed a combined US$300 billion by 2019, according to industry estimates. Related: Oilfield Services Feel The Pain As Crude Prices Drop
Before the U.S. tore up the JCPOA deal, Iran had been expected to add one million tonnes to its ethylene and propylene exports over the next two years. More specifically, from a risk/reward perspective, not only does the petchems sector generate revenues for Iran of around 15 to 16 times more per tonne of product than crude oil but for foreign investors, based on current contract terms, petchems yields rates of return of 30-35% against 12-15% in the upstream segment, a senior oil and gas industry source who works closely with Iran’s Petroleum Ministry told OilPrice.com.
Those companies that honour existing deals will also benefit from the new petchems contracts format, if their deals were not already signed under those terms, according to the Iran source. “The old contracts meant that investors needed to deposit as a pledge at least 130% of the capital investment amount required in a project in the petrochemical sector,” he said. The new contract model has replaced the excess deposit idea with one that sees the NPC taking the role of quasi-transactional guarantor.
“The NPC will have a lien against future petrochemical products to be produced by petrochemical plants that are under construction so, on the one hand, this will act as a pledge for repayment of private sector loans to banks and on the other it will give an assurance to the banks through which the money is funded that repayment will be made,” he said. “For its part, the NPC will retain at least a 20% share in new and under-construction petrochemical plants projects,” he added.
In a similar vein of improving the risk ratio for foreign investors is the push to increase the real rate of return of the petchems sector, at least in line with Western standards, Mehrdad Emadi, head of global risk analysis and energy derivatives markets consultancy, Betamatrix, in London, told OilPrice.com. Although the average rate of return on investment for foreign companies involved in Iran was over 20% just before sanctions were re-imposed, the National Iranian Oil Refining and Distribution Company (NIORDC) has sought to boost this where possible and to increase the profitability of output from its petchems plants.
Specifically, fuel oil production in Iran’s refineries currently still accounts for around 25% of their overall output, compared to a 12% world average and only 2% in European refineries. This is a comparative cost disadvantage for the country as the price of fuel oil is historically significantly lower than that of crude oil. “In order to redress this relative imbalance, the NIORDC issued a recommendation that its refineries operate projects for cutting their fuel oil production in order to increase overall margins,” said Emadi. In the same vein, he added, the NPC has reiterated a commitment to keeping the formula used for determining the price of petrochemicals unchanged for at least the next 10 years, so ensuring a minimum benchmark real rate of return for foreign investors for at least that period.
By Simon Watkins for Oilprice.com
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